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Thanks to Brian who took the time to respond to my 2/26 free trade opinion. Several of his comments illustrated that my article wasn’t terribly clear. I did edit it a bit since, and hopefully my points come across better now. However, the most interesting thing to me was his question, “Who said the trade deficit is bad?” He provided the following links which are certainly worthy of a good read.

The Cato Institute offers a not terribly balanced look at trade deficits. Keep in mind that the Cato Institute is regarded as a “libertarian” quasi-academic think-tank which acts as a mouthpiece for the globalism, corporatism, and neoliberalism of its corporate and conservative funders. I’ve included it in the spirit of offering the other side of the argument, but do wonder if Brian was just yanking my chain a bit.

By far, the more interesting discussion is here. I will warn you up front that this is a fairly heavy read, but I do think it’s worth 30 minutes of your time to study it. I learned quite a bit. After studying this, I do concede that trade imbalance is not the holistic indicator I perceived it to be. It is inexorably interdependent on GDP, domestic spending, and debt. However, in aggregate I remain steadfast that we are headed to economic disaster.

The essence of the above lesson is that trade deficits can be good things where the foreign invested or borrowed capital is being used to build infrastructure capability which ultimately is realized as GDP growth. Where GDP growth fails to keep pace with the trade deficits we create a future state where our standard of living must fall to pay for our extravagances now. To put this on a personal scale, running a trade deficit is similar to you taking out a loan from the bank. If you use that loan to start a successful business, the money earned ultimately pays for the loan and makes it a worthwhile investment. If the loan money is used to take a wild vacation, then you ultimately must pay off the loan in the future by redirecting income from your standard of living to pay the debt.

So how does this manifest itself in the U.S. ? In 2003, GDP was up 4.1%. Consumer spending was up 3.1%. Meanwhile the trade deficit rose by 17.1% The net-net of this is that our debt to and/or ownership by foreign investors increased in 2003. So the only question is, are we using that capital to increase our future GDP? If yes, then this could be considered healthy. If not, we are creating an inter-generational debt bomb which will detonate in the face of our children. We would be dooming them to a lower standard of living than we are enjoying, because they will be paying for our fiduciary sins.

So what are we spending our money on? Sending jobs overseas (as we’ve discussed before) increases our trade deficit. At present we are sending service sector jobs abroad, and they don’t really create GDP value. It can be argued that the lower cost effectively increases profit domestically, but I contend the net loss of jobs and drain on social welfare programs outweighs that benefit. Goods manufactured abroad by U.S. companies count as imports on our side of the equation. Granted, the debt side of importing is somewhat offset by the profit flow back to the U.S. corporate parent. So this is a lesser-evil import than one wholly owned by a foreign company. But still an import.

What about investment in this country? The government is mounting record debt. Is that being used to create/nurture future wealth? Most of the incremental debt is going toward military or security applications and social welfare. Neither of those contribute to GDP. Further, the relaxation of environmental regulations create the possibility that future generations will need to clean up the mess. Again, no value creation there.

Relative currency values also play in this. While a weaker dollar contributes to the ability of U.S. companies to export products (they sell for cheaper abroad), it also lessens the value of foreign investment in U.S. assets and decreases the relative value of domestic investments. They way I read this, if you are running a trade surplus, then you want a weak dollar. Trade deficits are best complimented by a strong dollar. And the value of the dollar is at record lows.

I encourage you to read the tutorial and draw your own conclusions. And I’d love you to share them. For me, I remain on the same page.